What does credit risk refer to?

Credit risk specifically pertains to the possibility that a borrower will be unable to meet their financial obligations as outlined in a loan agreement. This type of risk is significant for lenders, as it directly affects their potential profits and overall financial health. When individuals or entities borrow money, there is always a chance that they may default on the loan, which can lead to losses for the lender. This is particularly relevant in the context of banking, corporate finance, and investments, where assessing the creditworthiness of borrowers is crucial for making informed lending and investment decisions.

Understanding credit risk is essential for managing a financial institution's portfolio and for making prudent lending decisions, including setting interest rates that reflect the risk level associated with different borrowers. The other choices represent different types of financial risk but do not encompass the specific nature of credit risk, which centers primarily on the borrower-lender relationship and the likelihood of repayment.